Obsidian Energy Ltd. (OBE) Q3 2017 Earnings Conference Call Transcript

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Obsidian Energy Ltd. (NYSE: OBE)
Q3 2017 Earnings Conference Call Transcript
Nov 10, 2017, 08:30 a.m. ET

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Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning. My name is Jessa, and I will be your conference operator today. At this time, I would like to welcome everyone to the Obsidian Energy's Third Quarter Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, please press the pound key. Thank you.

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Mr. Brad Monaco, Manager of Corporate Planning and Investor Relations, you may begin your conference.

Brad Monaco -- Manager of Corporate Planning and Investor Relations

Good morning everyone, and thank you for joining us. This morning, we will be discussing our strong third quarter 2017 results and details around our 2018 budget. The format of this call will be audio only.

With me this morning and speaking on the call is Dave French, President and Chief Executive Officer; David Hendry, Chief Financial Officer; and Tony Berthelet, Vice President, Development and Operations. The rest of the leadership team is also in attendance.

Before I turn the call over to Dave, I would like to point out that we will refer to forward-looking information in connection with Obsidian Energy and the subject matter of today's call. By its nature, this information contains forecasts, assumptions, and expectations about future outcomes, so we remind you it is subject to the risks and uncertainties affecting every business, including ours. Please refer to our public disclosure filings available on both the SEDAR and EDGAR systems for a full discussion of significant factors and risks that could affect Obsidian Energy or could affect future outcomes for Obsidian Energy.

Go ahead, Dave.

David L. French -- President and Chief Executive Officer

Good morning and thank you all for joining us. I'd like to start the call by saying how pleased I am to share our third quarter results today. We have been relatively quiet externally over the last several months but I think this release gives you some idea that, inside, we were rolling along. We put together great results across every facet of the business, and this is a true testament to the Obsidian Energy team.

One of the things we've been most looking forward to talking about is our first foray into our Deep Basin position. Early indications from our three-well Mannville program are very strong. The walls are liquids-rich and flowing strong on choke. We're holding back the gas rates on these wells to manage pressure and hydrates but, more importantly, to get the most high-value liquids as possible. Our three wells are producing approximately 60 barrels per million, results that have meaningfully improved already attractive economics.

Our successful Q3 drilling program did not stop there. We are meeting or beating expectations across all key development areas. Our base performance in new well delivery gives us confidence to forecast production on the high end of guidance. Keep in mind, we lowered our total capital guidance by $20 million this past quarter. Tony will expand on these results later in the call.

Our full-year production is as strong as it is because of our shallow water flooding times and this keeps getting better. The investments we have made since third quarter of last year are starting to bear fruit. We are happy to highlight the powerful results seen today. In our entire Cardium position this year, decline is extremely shallow at 5%. This asset is a powerful foundation for cash with high margins, low production runoff, good capital efficiency, and strong liquids waiting that keeps us nicely able to participate in the current commodity strengthening.

That brings me to our 2018 plan. We are leaning into a shorter-cycle inventory in our portfolio next year, with lower cost integrated water flood and decline mitigation still very much a priority. In 2018, we conservatively plan to deliver 5% production growth while investing only 80% of funds flow from operations at strict pricing. This scalable budget leaves us room to draw on a deep inventory of drill-ready projects to expand development in the second half of the year should strong pricing continue.

Our board of directors approved a well-structured and toggleable 2018 budget of $135 million, with half of the development capital heading to the Cardium and the rest split between our other development areas.

In the Cardium, we plan to blend our integrated Type four and Type one waterflood approaches to be short-cycle focused, mainly, by not drilling new injectors and just converting existing producers. This reduces capital demand and still gives us a good producer to injector pattern management. We will also drill some primary Willesden Green wells in some of our halo acreage and expect an excellent rate profile from the mix of projects.

Our third quarter results demonstrate our ability to deliver both base production management and predictable liquids-weighted growth. This was a stand-and-deliver quarter for Obsidian Energy and, frankly, a genuine pleasure to talk about. We are excited about the momentum in the business and, as is usually the case, good operation performance translates well into solid financial performance.

With that, I will turn the call over to Dave Hendry to discuss our third quarter financial highlights.

David Hendry -- Chief Financial Officer

Thank you, Dave. Funds flow from operations for the third quarter was $40 million or $0.08 cents per share. This is a 25% increase from Q3 2016 due to higher commodities prices and lower operating and G&A costs which more than offset a smaller production base. We are slightly down from Q2 2017 due to the strengthening Canadian-US dollar exchange rate. Third quarter operating costs were $12.26 per boe net of our Peace River Carry as compared to $14.27 per boe in Q2. As expected, operating costs were lower in the second quarter of 2017 due to a reduction of repair and maintenance spend. We continue to target annual 2017 operating cost of approximately $13.00 to $13.50 per boe net of our carried expense. As a reminder, we forecast our Peace River carry to expire by the end of this year.

$55 million of capital expenditures were invested across the business in the quarter and we remain on-track to meet full-year 2017 capital guidance. Our cash margins continue to be solid with netbacks of $18.70 per boe in the third quarter, compared to $19.96 in Q2 with the difference being a decline in commodity prices which was partially offset by improved operating costs. Average liquid sales prices were $45.05 per boe and net average natural gas sales prices were $2.35 per MCF in the quarter. Realized natural gas prices were at a premium to AECO in the quarter as a portion of our gas volumes is marketed at alternative sales points. We expect our gas realizations to maintain a slight premium to AECO through 2018.

Total net debt was $410 million at the end of the third quarter, including $251 million drawn on our $410 million revolving credit facility and $113 million of senior notes. We had a larger working capital divested in the quarter, resulting from the time of payables related to our Q3 capital program. Commodity risk management gains of $2.24 per boe were realized in the quarter, driven by our strong crude oil and natural gas hedging position.

We expanded our hedge book this month to take advantage of an attractive crude price that supports our 2018 capital program and began to expand our hedge book into mid-2019. We now have approximately 2/3 of our liquids portfolio hedged for 2018, putting us in a position to better withstand commodity price volatility and manage our ongoing capital programs. We also took advantage of the October decline in the Canadian dollar relative to the US dollar and hedged approximately 2/3 of our foreign exchange exposure on our 2018 US dollar WTI hedges.

On the disposition front, we entered into agreement to sell our Alberta Viking royalties for $40 million. At over $200,000.00 per flowing barrel and 15x NOI, this transaction creates meaningful value for all stakeholders. Proceeds will be used to pay down debt and as neutral to 2018 funds flow from operation. Closing is anticipated for later this month. I will now pass the call to Tony Berthelet to take everyone through our busy operational third quarter.

Tony Berthelet -- Vice President of Development and Operations

Thanks, Dave. It was a truly exciting quarter for our company. We executed all development activity on-time and on-budget and our Q4 is also shaping up well. Our Q3 development activity was built on a platform of low-decline base production in our waterflood-supported Cardium acreage. Base decline in the Cardium is shallow to 5% year-to-date as a result of our waterflood and base optimization projects that began in the third quarter of 2016.

I can't overemphasize how important this is for our future growth profile of Obsidian Energy. The dollars we committed to putting water in the ground are delivering the expected results we have discussed over the last few quarters. In Pembina-Cardium Unit No. 9, we brought three horizontal producers on production subsequent to the quarter and early rate indications are exceeding type curve expectations.

We are currently drilling our four horizontal wells in Willesden Green and expect the pad to turnover to production prior to year-end. Both programs were developed using integrated waterflood support and we expect decline rates lower than typical primary wells.

In the Alberta Viking, our ten-well program continues to perform above budget. All 10 wells are in production, including the 100/2-18 well, which had a peak initial rate of 704 boe per day and a producing IP30 rate of 295 boe per day.

We continue to evolve our development strategy in the area to enhance overall economics, including trucking clean oil through a design change at our multi-well batteries and optimizing stage count to maximize capital efficiency.

Our second half 2017 Peace River Program returns to the heart of Harmon Valley South field and preliminary results of the program are encouraging. Daily total production from the first nine wells of the H2 program is currently 1,700 boe per day or approximately 190 boe per day per well and that's gross production. At present, 10 of our 12 second half wells are now on-production and two are under facility construction.

Obsidian Energy set another record in the third quarter for meters drilled with a single bit and bottom-hole assembly. The company drilled 17,278 meters of open hole on this week for an overall cost of just $76.00 per meter. In the Mannville, we drilled our three-well program in the third quarter with one well on production as of September 30th and the remaining two wells by the end of October.

While the first well encountered lower permeability and pressure than expected, our second and third wells moved to higher pressure areas of the reservoir and have significant initial liquid rates. These two wells are currently showing free condensate rates of 35 barrels per million standard cubic feet relative to expectations of 10 barrels per million. Overall, liquid rates on these wells are 60 barrels per million, more than double type curve expectations. We expect these yields to increase project yield of return by approximately 20%. We are maximizing the liquids potential of these wells by using a down-hold choke to stabilize gas rates at approximately 4 million standard cubic feet per day.

I echo Dave's comments on being proud of what we have accomplished this quarter. We have great assets and the team had a lot of fun developing them in the third quarter. Our current activity has established a strong foundation for 2018.

I'd now like to share some details of our 2018 capital program. Our significant portfolio optionality allows us to shift capital allocation in response to various commodity price scenarios and deliver a returns-focused capital program entirely supported by funds flow from operations and current strip.

As Dave Hendry touched on, our hedge position provides cash flow certainty, enabling our capital program to withstand more than a 10% decline in Canadian dollar realized oil and gas pricing before feeding our funds flow from operations. This gives us strength in a weak commodity environment.

The more relevant conversation, given this more recent strength in crude prices, is the flexibility we have to respond in the second half. Our program is 60% H1 weighted and, as commodity prices play out, we have the option to enhance development capital levels in the second half. We have a substantial project inventory ready to execute.

Our capital program supports the ongoing price of business, such as environmental, infrastructure, and maintenance but also includes nearly $15 million of one-time regulatory costs for the year. For example, we have a license to operate requirement in Peace River associated with AER Directive 84 where we will conserve, gather, and process gas to meet a September 2018 regulatory deadline.

Our developmental program is approximately 50% weighted to the Cardium and 10% to 15% each to our Deep Basin, Alberta Viking, and Peace River assets as well as an additional 15% to optimization of existing wellbores. The projected capital efficiency of our 2018 development program is approximately $15,000.00 per boe, based on the 12-month forward production associated with each of those projects.

Just under $45 million will go toward the Cardium, drilling six Pembina-integrated waterflood wells and two Willesden Green short-cycle Cardium wells. We continue to place our horizontal wells in the bioturbated rock just below the upper good-quality reservoir to ensure we access reserves in both the cleaner intervals above, as well as tapping into some portion of the undrained reservoir in the lower bioturbated interval. This is the approach we have used in 2017 wells and in our prior wells, specifically, our 2015 and 2016 Willesden Green programs which have very strong results.

Additionally, we will spend approximately $5 million on integrated waterflood and optimization opportunities within the Cardium. We're using a hybrid-Type one and four approaches in Pembina, where we will convert existing verticals to injectors to support new drills, a much more capital-efficient approach in a year with some one-off license to operate capital requirements.

$12 million from the Cardium budget will be allocated to non-op primary drilling by our working interest partners in the area and $4 million to land consolidation opportunities and seismic. We plan to drill three wells, spending approximately $11 million to continue development of our Deep Basin position in 2018.

We have high-graded our 2018 inventory to target liquids-rich high-pressure locations that generate robust rates of return, even with the current AECO outlook. Designing simpler wells to mitigate length of individual legs to drill faster has driven cost savings to attract capital to the Peace River area. We plan to invest approximately $8 million to drill five gross wells. Even with the end of the carry, we expect to drill highly economic prop wells in 2018.

Approximately $9 million will be allocated to Alberta Viking. We will drill six wells, offsetting our 2017 program and expect comparable production results. We expect slightly enhanced economics on our 2018 program, using multi-well pads close to existing infrastructure and by continuing to truck clean oil. We have identified more than 50 individual optimization projects to debottleneck, consolidate infrastructure, and test upward potential within our portfolio, spending approximately $14 million in 2018. This will generate some of the most capital-efficient spend in our 2018 budget, projected at less than $10,000.00 per boe per day. This is the focus in a year with additional regulatory requirements so we do not expect the same quantum of capital to be allocated past 2018.

Combination of our Cardium waterflood results, the success of our first Deep Basin program, and prop in Alberta Viking continued delivery leave me very excited for 2018 development and the continued performance our team has delivered in 2017.

That concludes our formal remarks. I'd now like to turn the call back over to the operator to open the call up for Q&A.

Questions and Answers:

Operator

Thank you. At this time, if you would like to ask a question, please press star followed by the number one on your telephone keypad. We will pause momentarily to compile the Q&A roster.

Your first question comes from the line of Sam Roach from Canaccord. Please go ahead.

Sam Roach -- Canaccord Genuity Limited -- Associate Analyst, Research Division

Thanks. Good quarter, guys. So, first question's for Dave, here. On the royalty sale, were those existing royalty assets or did you manufacture them? And can you just help me understand, do you see more opportunities to monetize existing assets and what we can expect from that in 2018?

David L. French -- President and Chief Executive Officer

It wasn't a manufactured royalty -- it was on third-party land so, on a previous sale, we had encumbered it with a GOR position and then we sold this third-party so there's no ongoing cost to Obsidian Oil past this disposition. As far as ongoing, we don't have any plans to continue to sell any GOR assets but, also, we look at opportunities as they come about.

Sam Roach -- Canaccord Genuity Limited -- Associate Analyst, Research Division

Great. Thank you and, just a quick follow-up, could you give any more details on the Mannville wells during the quarter -- maybe a breakdown by well-by-well, or test durations, or anything like that?

Tony Berthelet -- Vice President of Development and Operations

Yeah, sure. It's Tony, here. So, on the 14-30 well, that was the first well we drilled. That's been on-flow for about a month now so we're about 30 days in on that well. As is mentioned in the call notes, we did encounter lower reservoir quality there so, really, a degraded perm and a little bit lower pressure. That well came on about 3.2 million a day and it's stabilized out at about two million a day right now.

So, taking the learnings from that and, ultimately, that was just drilling into a different part of the channel and encountering a bit tighter rock. Second well was 2-7, just south of the 14-30 well, but into a different channel. That's been on-production about three weeks, definitely stronger pressure there. We maintained a down-hold choke in that well up until about a week ago and that well's flowing into our Willesden Green facility and, as we mentioned in the call, that has come on with higher free liquids rates of around 30 barrels per million of free condensate and another 30 of NGLs associated with that.

And then, finally, the 2-3 wells have been on production for just about two weeks now. This encountered the highest production at about 27 NPA reservoir pressure and, again, similar liquids rates to what we saw in the 2-7 well. We've got a down-hold choke in this well, still, and we're going to keep it flat at about 4 million per day just to manage flow into the facility. With these big liquids rates flooding into the facility has been a bit of a challenge so we're just managing that now with stabilized flow rates.

Sam Roach -- Canaccord Genuity Limited -- Associate Analyst, Research Division

That's excellent color. Thank you.

Operator

If there are any additional questions at this time, please press star followed by the number one on your telephone keypad. Your next question comes from the line of Thomas Matthews from Altacorps Capital. Please go ahead.

Thomas Matthews -- AltaCorp Capital Inc. -- Analyst of Institutional Equity, Research Division

Hi, guys. Sorry for my voice, but just, quickly, on going to the shorter-cycle Cardium program in 2018, so wondering, the Willesden Green wells that you'll be drilling, are the expectations that those are going to be similar to year 2015 and 2016 wells -- because, from what I recall, those were still into a water-flooded acreage -- or will you be pushing into more halo-type virgin rock in 2018?

Tony Berthelet -- Vice President of Development and Operations

Yeah, Thomas, this is Tony, here. Yeah, we're definitely drilling into the halo so this won't be similar to those 2015/16 wells where we were in the heart of the well-supported waterflood. These will be part of that typical halo production profile that you would see from wells offsetting our main unit production. So, these would be off to the east of the main unit development.

Thomas Matthews -- AltaCorp Capital Inc. -- Analyst of Institutional Equity, Research Division

Okay. And then, on into the partnership, would you disclose how many wells that would get you or what your average working interest is there?

Tony Berthelet -- Vice President of Development and Operations

No, we're still waiting. That's placeholder capital for the most part and we have lined our sights on a few wells but, ultimately, that'll shape up as the year progresses.

Thomas Matthews -- AltaCorp Capital Inc. -- Analyst of Institutional Equity, Research Division

Okay. Great. That's it for me, Thanks, guys.

Operator

There are no further questions at this time. We turn the call back over to the presenters.

David L. French -- President and Chief Executive Officer

Thanks for the questions, everyone. As we mark our first quarter results as Obsidian Energy -- the first full quarter -- this is often the time when I use some sports analogy to talk about the future of the company and what to expect. This quarter feels different, no interpreting required, just good, solid results. This is an exciting time for our business, as Tony and Dave said before me. We've been working hard at all levels of the organization to hang numbers and deliver a plan that demonstrates the power of our portfolio. Now is the time to keep this positive momentum going and to solidify our place among the very best of our peers and we intend to do just that. We look forward to catching up soon with all of you. Thank you for your continued support and have a great morning.

Operator

That concludes today's conference. You may now disconnect.

Duration: 23 minutes

Call participants:

Brad Monaco -- Manager of Corporate Planning and Investor Relations

David L. French -- President and Chief Executive Officer

David Hendry -- Chief Financial Officer

Tony Berthelet -- Vice President of Development and Operations

Sam Roach -- Canaccord Genuity Ltd. -- Associate Analyst, Research Division

Thomas Matthews -- AltaCorp Capital Inc. -- Analyst of Institutional Equity, Research Division

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